It’s a question often asked by many a director; “What salary should I take from my company?”.
A director may want to maximise their salary, base it on profits or make it as tax efficient as possible.
In this article, we focus on the latter – the most tax efficient salary a director can take.
One of the main benefits of running your own company is the wide variety of options available to you which can help reduce you tax bill. If you are a sole director this is of the most importance, as you can freely make changes to your company’s expenses to suit your needs. How you extract money from the company is one of them.
There are many taxes to be aware of as a director. You have Corporation tax at 19% of taxable profits, PAYE and NI if you take a salary, VAT at 20% of your sales (potentially), and then dividend tax.
As chartered accountants, it’s our job to make sure our clients are fully informed about their options when it comes to saving tax. Choosing an appropriate salary can save you money, whilst making sure you don’t miss out in other areas.
So why take a salary in the first place?
Good question, well the first reason is that you can’t spend that which isn’t yours.
If you start taking money out of your company willy nilly and not formally in the form of a salary or dividends, then it becomes a loan – and you can get taxed quite heavily on these. So, you will want to declare a salary and dividends in order to extract money from the company tax efficiently.
In fact, whilst we’re on the subject of dividends, don’t forget, you get £2,000 tax free every year! So it’s always worth declaring a £2,000 dividend if you can.
Also, it’s good to have a salary as a company expense, as it reduces your taxable profits!
Remember, that’s the one that gets taxed at 19%, so reducing your profits as much as possible, helps reduce your corporation tax bill.
But, after a certain point, the employee gets taxed more than the savings the company would make by having the salary. The precise salary at which this happens is the sweet spot we’re trying to find.
A salary takes advantage of a very crucial allowance – your “tax free personal allowance” worth £12,570 in 2021/22. So, as long as you have no other income, you can put a salary of £12,570 through the company for yourself and it will save you 19% corporation tax, and you won’t be taxed PAYE on it as an individual. Neat, huh?
We’ll not quite, as we will find out…
What about national insurance?
That’s right, whilst there will be no PAYE for you as an individual if your salary is under £12,570, the company will still have to make employer’s national insurance on any salary over the National Insurance Secondary threshold of £8,840 per year. Salary payments above this threshold will incur Employer NICs at 13.8%.
And then after £9,568 you start paying 12% employee NI.
So, what’s best?
Well, most informed accountants will say £8,840 is the most tax efficient. This is generally accepted in the accounting community. (Some even say £12,570 and that’s just ridiculous, but let’s no go there).
And it’s wrong!
Certainly, a salary of £8,840 will reduce your corporation tax by 19%, which equals a tax saving of £1679.60.
But, a salary of £9,568 saves £1,817.92 corporation tax, and whilst this incurs employer’s NI at 13.8%, (equal to £100.46, or £81.37 after tax), overall that’s still a bigger overall saving of £1,736.55.
Plus, if there’s more than one of you on payroll, you can claim employer’s national insurance allowance, which means you don’t even have to pay the extra 13.8% (£81.37 per director).
After £9,568 you then have to start paying 12% employee NI on the salary, which takes the overall tax on the salary up to 13.8% + 12% = 25.8%, which is now more than 19% corporation tax saving it would make.
So that’s it, £9,568 is the most tax efficient salary for a director.
However, if you’re a sole director, you may wish to consider taking only the £8,840, as you don’t have to bother with making the monthly payments to HMRC then for the PAYE, which would be advisable.
The good news about the state pension
Finally, as long as your earnings are above the lower earning limited of £6,240 you will accrue qualifying years to wards your state pension. Great news!
How can I pay myself a salary?
A salary like this needs to go through payroll. That’s where you typically pay yourself monthly and receive a payslip each time.
Xoba’s payroll service for directors is just £10 per month for the first director, and £2 for each additional director, with a £100 annual compliance fee.
That means, for two directors, you pay £244 for the service and would you would make a tax saving of £3,359.20 each year.
Take any other profits out as dividends, as they get taxed at a low rate – plus you get your £2k dividend allowance each year.
And that’s it! You are now extracting the profits from your company in the most tax efficient way.
For more information, or if you would like to start your director’s salary, please contact our office on 01772 367303.
We hope you can see the benefits of such as salary and we look forward to hearing from you!